Did moving out of Virginia before an S corporation sold its assets keep the entire capital gain outside Virginia tax?

Subject

The sale of assets by Corporation A resulted in income subject to proration

Plain-English summary

Virginia prorated the S-corporation capital gain by the shareholders' Virginia residency days even though the asset sale occurred after they moved. The husband and wife left Virginia in April 2004, and the husband's S corporation sold its assets in September.

Virginia's policy allocated part-year residents' pass-through income according to the number of days they lived in Virginia. A narrow exception could apply when a clearly defined cutoff of entity activity divided the periods.

No cutoff occurred here. The same S corporation continued operating throughout 2004; only the shareholders changed residence. The later asset sale therefore produced pass-through income subject to daily proration, and the assessment was upheld.

What this means for you

• The payment or sale date alone may not control Virginia treatment of annual pass-through income.
• Moving does not create a cutoff in the entity's business activity.
• Document actual cessation, restructuring, or other entity events if claiming a distinct activity period.

Common questions

Was all of the September gain assigned to the new state? No.

Why did Virginia prorate it? Corporation A remained in operation for the full year, so no clear activity cutoff limited the proration period.

Citations and references

• Va. Code § 58.1-303(B).
• 23 VAC 10-110-40.
• P.D. 95-184 (July 14, 1995).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-8

Original ruling text

January 11, 2008

Re: § 58.1-1821 Application: Individual Income Tax:

Dear *:

This will reply to your letter in which you seek correction of the individual income tax assessment issued to * (the "Taxpayers") for the taxable year ended December 31, 2004.

FACTS

In April 2004, the Taxpayers, a husband and wife, abandoned their Virginia residency and established residence in * (State A). The husband was the sole shareholder of an S corporation (Corporation A) located in State A. In September 2004, Corporation A sold its assets and realized a capital gain through the resulting distribution. The Taxpayers filed a part-year Virginia individual income tax return for the 2004 taxable year and attributed all of the gain to State A.

The Taxpayers were audited and the auditor attributed a portion of the gain to Virginia in proportion to the number of days that the Taxpayers resided in Virginia. The Taxpayers contest this assessment, asserting that the gain should be attributed to State A because the gain occurred while they were residents of State A.

DETERMINATION

Virginia Code § 58.1-303 B states:

Any person who, on or before the last day of the taxable year, changes his place of abode to a place without the Commonwealth with the bona fide intention of continuing actually to abide permanently without Virginia shall be taxable as a resident for only that portion of the taxable year during which he was a resident of Virginia and his personal exemptions shall be reduced to an amount which bears the same ratio to the full exemptions as the number of days during which he was a resident of this Commonwealth bears to 365 days.

Title 23 of the Virginia Administrative Code 10-110-40 provides that individuals who are residents of Virginia for only part of a taxable year are only taxed as residents for that portion of the year that they reside in Virginia.

The Department's policy with regard to a part-year resident's distributive income from a pass-through entity is established in Public Document (P.D.) 95-184 (7/14/1995). In accordance with P.D. 95-184, a part-year resident must determine income from a pass-through entity attributable to the period of Virginia residency by prorating the income in accordance with the number of days he was a resident of Virginia during the taxable year. A part-year resident is not entitled to a credit for taxes paid to another state with respect to income from a pass-through entity that has been excluded from Virginia source income pursuant to this policy.

In the instant case, the sale of assets by Corporation A resulted in income subject to proration as determined in P.D. 95-184. The Taxpayer argues that P.D. 95-184 states the proration of distributions method applies if there is a "clearly defined cut-off of activity." The Taxpayers assert that because the sale occurred after they moved to State A, no part of the gain should be included in Virginia taxable income.

I do not agree with the Taxpayers' interpretation of the ruling. In P.D. 95-184, the clearly defined cut-off of activity occurred when the S corporation operating in the other state ceased operations. The fact that the taxpayers moved to Virginia had no bearing on when the activity of the S Corporation was cut off. A new S corporation was then started in Virginia. Because an S corporation ceased operations in the other state and a new corporation was started in Virginia, a clear cut-off of activity occurred that limited the proration periods. No proration applied only because the taxpayers moved to Virginia on the date that the clear cut-off of activity occurred. This narrow exception to the Department's policy resulted from a unique set of circumstances.

In this case, no such clear cutoff of Corporation A's activity occurred. The Taxpayers merely moved from Virginia to State A. Corporation A remained in operation for the entire year. As such, the Taxpayer's income from capital gain must be prorated in accordance with the number of days that the Taxpayers resided in Virginia in 2004.

As such, the auditor's assessment is upheld. A revised bill, with interest accrued to date, will be sent to the Taxpayers. No additional interest will accrue provided the outstanding balance is paid within 30 days from the date of the revised bill. The Taxpayers should remit payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attention: *. If you have any questions concerning payment of the assessment, you may contact at **.

The Code of Virginia section, regulation and public document cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's website. If you have any questions regarding this determination, please contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

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